How to Draft LLC Operating Agreements

By River Braun, J.D.

How to Draft LLC Operating Agreements

By River Braun, J.D.

A Limited Liability Company (LLC) is a business entity that combines some of the best advantages of a sole proprietorship and a corporation. Many small businesses choose this type of business structure because it is flexible, provides some protection from personal liability, is a pass-through entity for tax purposes, and is easy to set up and operate. Drafting an operating agreement is one of the first steps in forming an LLC.

Coworkers sitting around a conference table collaborating

Operating Agreement

The operating agreement is similar to a corporation's bylaws. Each LLC has a unique operating agreement that outlines the understanding between the members regarding ownership interests and details of operating the business. In a multi-member entity, the operating agreement becomes a binding contract on all members. Therefore, drafting one may require extensive discussions and negotiations between members to work out the various elements of the agreement.

State law governs several aspects of the business operations and structure in the absence of an operating agreement. Therefore, members should always draft an agreement to avoid the company being subject to the state default rules. This type of agreement also protects the limited liability status of the company, so members are not subject to the personal liability that partners and sole proprietors face.

Common Clauses in an Operating Agreement

The specific needs of the company and the desires of the individual members dictate the terms of the operating agreement. However, it should always contain certain standard clauses, some of which include:

Owners, Ownership Interests, and Job ResponsibilitiesThe agreement should include the business name, purpose, principal place of business, and the name and address of the registered agent. Additionally, it will also include the names, addresses, and interest owned by each member. Their capital contribution determines the size of the member's interest in the company.

Term and Tax Treatment

Separate clauses define the terms and tax election of the LLC. The terms can be short, particularly for a business being created for only one single event. Alternatively, the company can exist over a longer period of time, with automatic renewal. With regard to tax election, the entity can choose to be taxed as a corporation, partnership, or sole proprietorship.


Apportionment of Profits and Losses

The operating agreement governs the allocation of profits and losses among members. The size of the member's capital contribution determines their portion of the company's profits and losses. The agreement also outlines when and how members receive distributions of profits.


Identification of Managers and Management Duties

Members may designate the duties and management responsibilities among them. Some members may have greater management responsibilities and decision making authority than others. The agreement may also include details regarding salaries and compensation for both managers and members. Members may either manage the LLC themselves or elect a manager to handle the daily operations.

Changes in Ownership

Clauses explaining changes in ownership are very important to ensure the business continues to operate even though members may change. The agreement should contain detailed instructions for adding, withdrawing, and transferring shares, along with how to handle a member's death. Other clauses may include restrictions on the transfer of ownership interest, anti-dilution provisions, dispute resolution provisions, buy-sell agreements, and veto rights.

Dissolution of the Company

The members should identify how the company will be dissolved. This clause includes the provisions and conditions for closing and dissolving the company, including each member's responsibility in terms of voting, meetings, and what other steps are required in order to properly dissolve the company.

If you are using a template or sample when creating an operating agreement, keep in mind that the sample is a basic template, not a final agreement. Samples you find online are not tailored to your company. Review and modify each clause as necessary to ensure that the agreement encompasses the operating details you desire for your company and complies with all applicable laws in your state.
